This is slow pitch...batter hits the ball and somehow comes into contact with the ball in fair territory as she steps out of the box towards first base. Ump immediately calls batter out. Then places the runner who was on 1B on 2B. Was this the wrong call? There is no way the runner should be awarded 2B, is there?

Wrong. Runner(s) do not advance on a dead ball situation as you describe. I have not seen this at any level of softball that I have umpired.

ASA 8-2-F EFFECT
 

It's an interference call. Same as if a runner on a base got hit with a batted ball. Dead ball, yer out. Runners return to the last legal base touched at the time of the interference.

Sounds like your Blue got it wrong.